The Monetary Policy Committee has an impressive record of controlling inflation. So why are its own members rubbishing its performance?

WHEN the government handed over control of interest rates to the Bank of England's Monetary Policy Committee (MPC) in 1997, some commentators were unimpressed. Now, after two years of consistently low inflation, most critics have eaten their hats. But at a conference on the British economy on May 27th, organised by the Institute of Economic Affairs, a think-tank, one distinguished economist said that the MPC had largely been lucky. Sour grapes? Not at all. The accuser, Charles Goodhart, is himself a member of the committee.

What accounts for Mr Goodhart's surprising modesty? First of all, he does not think that the MPC can properly take all the credit for the low inflation of the past two years. The MPC's remit is to keep inflation as close as possible to the government's target of 2.5% a year. It tries to achieve this by raising or lowering the interest rate at which the Bank of England lends money to commercial banks. Higher interest rates, at least in theory, make people more reluctant to borrow and spend, and so should help cut inflation.

The problem is that inflation does not respond to interest-rate changes straight away. It takes time for rate changes to feed through to the real economy, and even longer for them to have their full effect on the rate of inflation. How long? Around two years, thinks Mr Goodhart. But the MPC has been in operation for only two years. In other words, much of the credit for Britain's recent spell of low inflation does not belong to the MPC at all, but can be attributed to the interest-rate decisions taken before itwas set up, by the then chancellor, Kenneth Clarke. Mr Clarke, much criticised for “taking risks” with inflation, may enjoy the vindication.

So what? Mr Goodhart's modesty is commendable. But if interest rates do affect inflation with a two-year delay, then future inflation will indeed reflect the MPC's decisions. And although academics quibble about individual interest-rate decisions, most applaud the MPC's overall record. Interest rates were raised progressively until last summer, when people feared an inflationary boom, and have been cut sharply since then, to head off a recession. Such a swift about-turn would have been more difficult if interest-rate decisions had remained in the hands of a politician, sensitive to the opinion polls.

Yet there is a problem, for inflation is not influenced only by interest rates. A strong pound, for example, lowers the sterling price of imported goods, and can reduce inflation. So can a recession in a country with which Britain trades. On the other hand, an expansionary British budget can push it up, and quickly. The pound, the chancellor, and overseas economies may affect inflation faster than the MPC's interest-rate decisions. Trying to control short-term inflation with interest rates alone is like trying to eat Chinese food with only one chopstick.

For these reasons, even if the MPC's actions succeed in keeping inflation on average at its 2.5% target, you would expect significant fluctuations around that target in the measured inflation figures. When the chancellor obliged the MPC to write to him to explain whenever measured inflation differed from the target by more than one percentage point, Mervyn King, now one of the Bank's deputy governors, joked that this edict would restore the lost art of letter-writing. In fact, the MPC has not had to write the chancellor a single letter. It is not just the rate of inflation that has stayed low. But the fluctuations in inflation—in technical terms, a standard deviation of 0.24—have been smaller than ever before (see chart).

Can this continue? Up to a point. When the rate of inflation is low, the fluctuations in the rate of inflation also tend to be smaller. But the almost bull's-eye precision of the inflation figures in the past two years has been due to a lot of different factors cancelling each other out. Hints of domestic inflation—such as rising labour costs—have been balanced by the strong pound and the financial crisis in Asia.

The MPC, whose only weapon is interest-rate changes, cannot ensure that this balancing act continues. But Mr Goodhart worries that people do not understand this. If the inflation figures suddenly, say, go up, people will see it not as an expectable fluctuation, but as a sign that the MPC has lost its touch. So he thinks it vital to educate people about the limits of what the MPC can reasonably be expected to achieve. Either that, or just pray that their luck continues to hold.